2017, Study Session # 3, Reading # 13 “TECHNICAL ANALYSIS” Trend in prices Reaching higher highs & retracing higher lows.. Breakdown below uptrend line significant price change.. Break
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“TECHNICAL ANALYSIS”
Trend in prices
Reaching higher highs & retracing higher lows
Show, demand is
Trend line connects increasing lows
Breakdown below uptrend line (significant price change)
Lower lows & retracing lower highs
Show, supply is
Trend line connects decreasing highs
Breakdown above downtrend line (significant price change)
Price range in which buying activity is sufficient to stop decline in price
Price range in which selling activity
is sufficient to stop rise in price
Change in polarity
Breached resistance levels become support levels & vice versa
12 c
S.D = Standard Deviations M.A = Moving Average M.V = Market Value MACD = Moving Average Convergence/Divergence
Types of price charts
Line charts Bar charts Candlestick charts Point & figure charts
Show closing prices as data points on a continuous line
Opening & closing &
high & lowprices
Use cross-hatches &
vertical lines as symbols
Same data as bar charts
Use boxes shaped as candle’s body for opening & closing price
Price moves are much more visible
∆ in the direction of price
Horizontal axis reflects
no of ∆ in price not time
Price change represents the height which is “box size”
Volume Chart
Usually included at the bottom of many charts
Volume on vertical axis
Relative strength analysis
Assets closing price Benchmark value
in trend, asset is outperforming & vice versa
12 b
Charts of price & volume
Exponential price change ⇒ charts on a log scale
Time interval reflects horizon of interest
Study of collective market sentiment
Prices are determined by interaction of supply & demand
Key assumption of T.A is that EMH does not hold
Usefulness is limited in illiquid markets as well as markets subject to large outside manipulation
Comparison Technical Analysis Fundamental Analysis
Share price & trading volume Intrinsic value
Data is observable Use F.S & other information
Can applied on assets without C.F
12 a
T.A = Technical Analysis
F.S = Financial Statements
C.F = Cash Flows
ROC = Rate of Change
RSI = Relative Strength Index
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Reversal Patterns
Signals the end of a trend
Head & shoulder patterns must be preceded by uptrend & inverse H&S must be preceded by downtrends
Analyst use size of H&S pattern to project price target
Double top & triple top
Indicate weakening buying pressure (Similar to H&S)
Selling pressure appears after resistance level
Double bottom & triple bottom for downtrends
Continuation Patterns Used to predict the resumption
of a market trend
Triangles
Form when the range between high and low prices narrows
Can be symmetrical, ascending or descending
Suggest buying & selling pressure roughly equal
Measuring implication: height of triangle at formation
Rectangles
Form when trading temporarily range b/w support & resistance level
Is a form of continuation pattern with one formed by connecting the high prices and the other by connecting the lows
Flags & pennants ⇒ Form over a short period of time, on a daily price chart
Price based Indicators Moving avg lines
Mean of closing prices over a specified number of periods
The longer the time-frame used to create M.A “n”, smoother the avg line
Uptrend price is higher then moving avg & vice versa
M.A for different periods can be used together
Golden cross: Short-term M.A crosses from underneath long-term M.A, buy signal Dead cross: Short-term M.A crosses from above long-term moving average, sell signal
Bollinger bands
Based on S.D from average price over last n periods
Analyst draw high & low bands above & below n-period M.A
Long-term investors may buy (sell) when price significantly exceeds (falls below) the upper (lower) bound
Contrarian strategy ⇒ Buy (sell) when price reaches the upper (lower) band
Oscillators
Tool to identify overbought or oversold market
Based on M.P but scaled so that they “oscillate” around a value or between two values
Charts used to identify convergence or divergence of oscillator & M.P
Convergence ⇒ same pattern as security, divergence ⇒ Oscillators demonstrate vice versa
Examples of oscillators
ROC or Momentum
100 × Diff b/w last closing price &
closing price x days ago
Buy when oscillator into crosses
positive territory & vice versa
Can be around 0 or around 100
Ratio of = Total price Total price
Oscillate b/w 0-100
Value> 70 ⇒ overbought
Value < 30 oversold
Use exponentially smoothed M.V
Oscillate around 0 but not bounded
MACD and signal lines used in technical analysis in three ways: Crossover between signal line and the MACD;
trends lines on the MACD itself; and the MACD in or outside range
Calculated from latest closing price & highest & lowest prices
Use two lines bounded 0 &
100
%k = diff b/w latest price &
recent low as % of diff b/w recent high & lows
Average of the last three %K values calculated daily
12 d
12 e
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Non-Price-Based Indicators
Sentiment indicators ⇒ to gain insight into trends
Bullish⇒ increasing prices, bearish ⇒ decreasing prices
Opinion polls⇒ measure investors’ sentiments directly
a Sentiment Indicators
Put/call ratio = Put volume
Call volume
Ratio ⇒ market sentiment is extremely negative; likely increase in price
Viewed as contrarian indicator
Extremely high ratio ⇒ bearish outlook & vice versa
1 Put/Call Ratio
Measure volatility of options on S&P 500 stock index
High VIX ⇒fear declines in stock market
Technical analysts interpret VIX in contrarian way
2 CBOE Volatility Index (VIX)
in M.D, buying, when reach their limit, buying ,
prices , investor sell securities to meet margin calls
M.D coincides with prices & M.D with prices
3 Margin Debt
Short interest is no of shares borrowed & sold short
Short interest ratio = short interest / Avg daily trading volume
Some analysts may believe that if ratio increases market should
express decrease in price and vice versa
4 Short Interest Ratio
b Flow of funds indicators
Useful for observing changes in demand & supply of securities
1 Arms index or short-term trading index (TRIN)
Measure of funds flowing into or out of advancing &
declining stocks
TRIN =
Index value close to 1 ⇒ flowing evenly to advancing &
declining stocks
Value > 1 ⇒ majority in declining stocks, value < 1 ⇒ majority in advancing stocks
2 Margin debt
Margin debt ⇒ investor wants to buy more stocks & vice versa
3 Mutual fund cash position
Ratio of = fund’s cash/total assets
Uptrend ⇒ ratio & vice versa
T.A analysts view as contrarian indicator
4 New equity issuance
IPO add to supply of stocks
Secondary issues do not increase the supply of stock but rather increase shares available for trading
Issuer tends to issue when market peaks, so issuance coincide with high price
Cycle theory is study of processes that occur in cycles
Cycle Periods Presidential Cycles Decennial Patterns Kondratieff wave Tied to U.S Presidential
elections cycle with the third year being prior to election year
Broken down on the basis of the last digit in the year; years ending with a 0(5) have had the worst (best) performance
54-year
12 e
12 f
Kondratieff wave 18-year Cycle
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Elliott wave theory
Financial market prices ⇒ described by interconnected set of cycles
Waves ⇒ chart patterns, uptrend ⇒ 5 upward waves, 3 downwards &
vice versa in downtrend
Ratios of the size of the subsequent wave ⇒ Fibonacci ratios
Fibonacci sequence starts with the numbers 0, 1 and 1, and the each
subsequent number in the sequence number in the sequence is the
sum of the two previous numbers
Ratio of 0.618 and 1 618 used to project price targets
Intermarket analysis
Analysis of interrelationship among M.V of asset classes (e.g stocks, bonds)
Relative strength ratio ⇒to identify outperforming asset class, then assets within class